Huntington Bancshares Incorporated Q1 2009 Earnings Call Transcript

Apr.21.09 | About: Huntington Bancshares (HBAN)

Huntington Bancshares Incorporated (NASDAQ:HBAN)

Q1 2009 Earnings Call

April 21, 2009 1:00 pm ET

Executives

Jay Gould – Director of Investor Relations

Stephen D. Steinour – Chairman, President and Chief Executive Officer

Donald R. Kimble – Chief Financial Officer, Executive Vice President and Treasurer

Tim Barber – Senior Vice President, Credit Risk Management

Nicholas G. Stanutz – Senior Executive Vice President, Auto Finance and Dealer Services

Michael Cross – Executive Vice President and Senior Commercial Lending Officer

Analysts

Ken Zerbe - Morgan Stanley

Scott Siefers - Sandler O'Neill & Partners, LP

Terry McEvoy - Oppenheimer & Co.

Anthony Davis - Stifel Nicolaus & Company, Inc.

Mark Lynch - Wellington Management

Greg Ketron - Citigroup

Operator

Good afternoon. My name is [Abigail] and I will be your conference operator today. At this time I would like to welcome everyone to the Huntington first quarter earnings call. (Operator Instructions)

Mr. Gould, you may begin your conference.

Jay Gould

Thank you, [Abigail], and welcome everybody. I am Jay Gould, Director of Investor Relations for Huntington.

Copies of the slides we will be reviewing today can be found on our website, Huntington.com. This call is being recorded and will be available as a rebroadcast starting about an hour from the close of the call. Please call the Investor Relations Department at 614-480-5676 for more information on how to access these recordings for playback or should you have difficulty getting a copy of the slides.

Slides 2 and 3 note several aspects of the basis of today's presentation. I encourage you to read these, but let me point out one key disclosure. This presentation contains both GAAP and non-GAAP financial measures where we believe it helpful to understanding Huntington's results of operations or financial position. Where non-GAAP financial measures are used, the comparable GAAP financial measure as well as the reconciliation to the comparable GAAP financial measure can be found in the slide presentation and its appendix, in the press release, in the quarterly financial review supplement to today's earnings press release or in the related Form 8-K filed earlier today, all of which can be found on our website.

Today's discussion, including the Q&A period, may contain forward-looking statements. Such statements are based on information and assumptions available at this time and are subject to change and risks and uncertainties which may cause actual results to differ materially. We assume no obligation to update such statements, and for a complete discussion of the risks and uncertainties, please refer to this slide, the material filed with the SEC, including our most recent Forms 10-K, 10-Q and 8-K filings.

Now turning to today's presentation, as noted on Slide 5 participating today are Steve Steinour, Chairman, President and Chief Executive Officer, Don Kimble, Executive Vice President, Chief Financial Officer, and Tim Barber, Senior Vice President of Credit Risk Management. Also present for the Q&A session is Nick Stanutz, Senior Executive Vice President of Auto Finance and Dealer Services, and Mike Cross, Executive Vice President and Senior Commercial Lending Officer.

Let's get started. Steve?

Stephen D. Steinour

Thank you, Jay. Welcome, everyone.

Now that I've been here just a little over 90 days, I think you should know that progress has been made, with much more in process that will set the stage for improved performance for Huntington.

I hope that message comes out loud and clear throughout this presentation. Yes, we reported a very large loss for the quarter, but this was due to a non-cash item that had no impact on the key operating dynamics of the company and the key issue of capital.

Our regulatory intangible common equity ratio's improved significantly this quarter and our balance sheet has never been more liquid.

For the quarter, our pre-tax pre-provision earnings rose 13%. We grew core deposits at a 9% annualized rate and we originated or renewed $4.4 billion in loans.

So we are clearly in challenging times and that will continue to be reflected in our credit quality performance, but I believe we are addressing our risks aggressively and proactively and I do not see any blowouts coming from the existing portfolio.

More on all of this as we go through the presentation. Let's begin.

Turning to Slide 6, I want to begin with a review of the first quarter performance and achievements. Don will follow with a detailed review of first quarter financial performance and comments on investment securities and capital. Tim will update you on credit quality trends. And I will close with my assessment of where we are and what our priorities are for the next 90 days.

So turning to Slide 7, as you know, we reported a net loss of $2.4 billion or $6.79 a share, however, we believe a more indicative measure of our first quarter performance was core net income of $6.9 million excluding the impact of three significant items shown on the slide and the payment of preferred dividends. After consideration of preferred dividends on per share basis, we had a loss of $0.06 per share.

Another way we look at performance is to look at earnings on a pre-tax pre-provision basis, also excluding the significant one-time items. We will be exiting this credit cycle some time, I hope soon, and this metric helps us assess if we are making progress at growing core earnings and the implications of our earnings power once we come out at the other end of the cycle.

We're clearly making substantial progress. Our pre-tax pre-provision income was $225 million, up 13% from the fourth quarter. Other highlights include our tangible common equity ratio improved 61 basis points to 4.65% and our TCE to risk-weighted assets ratio was 5.19%, up 80 basis points. We think this latter measure is a better metric to assess tangible common equity in that it takes into consideration the riskiness of the balance sheet.

Our allowance for credit losses was 2.24% and our net interest margin was 2.97%, a bit lower than anticipated, reflecting our efforts to improve the efficiency of the balance sheet and largely the impact from the Franklin restructuring.

Loan originations were particularly robust and our 9% annualized growth rate in core deposits was evidence that our reprioritization on generating deposits is achieving the desired impact.

Expenses were very well controlled, down 6% excluding the goodwill charge. We are on our way to exceeding our $100 million of expense saves for this calendar year.

On Slide 8 we review the activities that influenced these results and set the stage for a stronger performance.

A big highlight was the successful restructuring of our Franklin relationship announced on March 31. We covered all of this in detail in an earlier presentation so we won't rehash them, but bottom line, we ended last year with a net exposure to Franklin of $520 million, the $650 million in loans minus the $130 million Franklin-related allowance for credit losses. At March 31 our total net exposure to Franklin was $477 million, a $43 million reduction which translated into 8% for the quarter. So Franklin exposure continues to reduce. In addition, the restructuring has better positioned us to manage further reductions and our ultimate recoveries.

During the quarter we took proactive steps to increase our capital ratios. This included the difficult decision to cut the quarterly dividend on the common stock to $0.01. We also converted 114,000 shares of Series A preferred stock into 24.6 million shares of common stock. And we increased the efficiency of our balance sheet by securitizing auto loans, selling some of our municipal securities, as well as selling some of our mortgage loans.

The sum of these actions combined with the others listed here contributed to a $1.5 billion increase in cash on hand. This is the most liquid our balance sheet has been in recent memory.

We made significant progress in our management team restructure. This included hiring a new executive for our special assets group, a new executive to lead our commercial real estate lending group, and the hiring of a new executive to head up strategy and business segment performance.

We also realigned the regional into separate commercial and retail small business groups, headed by veterans Jim Dunlap and Mary Navarro, respectively.

And we implemented a cost-cutting initiative aimed at reducing 2009 expenses by $100 million, a target we already expect to see.

Lastly, as you will notice in the presentation and its appendix, we continue to very materially expand the level of detail in our external disclosures so as to improve our transparency to you and all others.

On Slide 9 are details of all the actions taken to strengthen risk management. Obviously, we've been very proactive in strengthening core capabilities. I won't cover each of these, but I think it's important that you know that our objective was threefold. First, we have adopted a more centralized view of portfolio management. Second, we've established common risk criteria and a common approval process across the franchise. And third, we've strengthened accountability at all levels.

Now to de-risk the balance sheet, we closed out-of-region auto finance operations, placed a hard cap on commercial real estate lending exposure, and will not longer support out-of-market projects for in-market developers. And we took the other actions listed here.

So in sum, we've reduced our risk appetite, improved our credit-related MIS and management practices, added more resources to risk management areas, and tightened lending practices with a centralized view on risk management. These important steps lay the groundwork for consistent, sustainable credit quality improvement and long-term performance.

Let me turn the presentation over to Don to review the financial performance.

Don?

Donald R. Kimble

Thanks, Steve.

Turning to Slide 10, we provide a summary of the earnings for the quarter. Our reported net loss for the quarter was $2.4 billion or $6.79 per common share. However, adjusted for three significant items, our core net income was a positive $6.9 million, with an EPS loss of $0.06 per share.

These three significant items were, first, the non-cash $2.6 billion or $7.09 per share goodwill impairment charge. The writedown of this non-earning intangible asset reduced net income but has no impact on tangible common equity, regulatory capital, liquidity or ongoing operations of Huntington. This charge reflects a significant reduction in the stock prices of our common and preferred shares that occurred during the first quarter. With the decline, we updated our impairment test and recognized the $2.6 billion non-cash charge this quarter. We have $452 million of goodwill remaining on our balance sheet.

Second, $159 million or a $0.44 per share tax benefit resulting from the Franklin restructuring.

And finally, an $0.08 per share one-time negative impact from the converted preferred stock that occurred during the quarter. This one-time negative impact reflects the value of the additional common shares issued to induce the conversion and is not recurring.

Slide 11 provides a summary of our quarterly earnings trends. Many of these items will be reused later, so let's move on.

On Slide 12 we provide an overview of our pre-tax pre-provision performance metric. We believe this metric is useful in assessing the underlying operating performance. We calculate this metric by starting with pre-tax earnings then including three items - provision for credit losses, security gains and losses, and amortization of intangibles. These three items tend to show greater volatility throughout the economic cycle.

Our pre-tax pre-provision income for the first quarter was $225 million, up $25 million or 13% from last quarter. This change reflected increases in certain income categories, specifically mortgage and brokerage insurance, and the improvement also showed the impact of expense reductions achieved during the first quarter. Offsetting these improvements was a decline in our interest income, which will be reviewed later. This linked quarter improvement clearly reflects the management actions taken during the quarter. Continue to look for additional steps to improve our core operating performance.

Slide 13 provides a trend of our net interest income and our margins. During the first quarter our net interest income declined by $38.9 million, reflecting a $1 billion decline in average earning assets and a 21 basis point decline in our net interest margin. The margin decline reflected the impact of our actions taken to improve our balance sheet liquidity position, the higher levels of non-performing assets, including Franklin, and the competitive pricing experienced in our markets.

Continuing on to Slide 14 we show the linked quarter loan and lease trends. Total commercial loans were down $0.3 billion or 1%, reflecting the impact of the chargeoffs taken over the last two quarters. The decline in auto loan and lease balances reflected a slight impact from the $1 billion securitization completed late in the quarter, as well as the continued run off of our lease portfolio.

One of the highlights for the quarter was the growth in our core deposits. Not only did we grow total core deposits at an annualized 9% rate, but each category grew, with the largest increase realized in the non-interest bearing deposits. We're continuing to emphasize core deposit growth through incentive programs and management goals. We are very pleased with the results to date.

Slide 16 shows the trends in our net interest income categories. Two highlights for the quarter were mortgage and brokerage. Mortgage originations more than doubled from the prior quarter to $1.5 billion. Mortgage fee income also benefited from the improved MSR hedging results for the quarter. We achieved record levels of retail investment sales for the quarter, contributing to the $8.7 million increase in the brokerage and insurance revenue. Service charges and trust revenues were down from the previous quarter, reflecting the seasonal and market conditions.

Slide 17 highlights some of the mortgage banking trends over the last five quarters. The subtotal included on the fifth line of this table provides an indication of the core performance of the mortgage business. The first quarter results also do include a $4 million benefit from the sale of approximately $200 million of portfolio mortgage loans completed late in the quarter.

Another highlight for the quarter was our expense management. Adjusted for the $2.6 billion goodwill impairment charge, our non-interest expense was down $23 million. Most of this reduction comes from our reduction in total personnel costs, which reflects the implementation of our expense reduction initiatives. Our staffing levels are down 11% in the first quarter of 2008.

Slide 19 provides a summary of our $4.9 billion investment portfolio. The portfolio is up $524 million from last quarter end, reflecting the addition of around $260 million in securities from our auto securitization and increases in the portfolio used to provide collateral as we decreased trading account balances used for this purpose last quarter. Our investment portfolio now reflects the $600 million decline in our municipal securities portfolio, offset by increases in our Treasury and agency related securities. The sale of the municipal bonds was completed to improve the credit and liquidity position of our investment portfolio.

The three highest risk segments of our investment portfolio are shown on Slide 20 - our Alt-A mortgage-backed portfolio, our pooled trust preferred securities, and our prime CMO segment. Over the last three quarters we've recognized about $200 million of impairment, including $3.9 million this quarter.

It is important to note that we have not adopted the revised accounting standards this quarter as we continue to assess the impact. If we would have adopted these standards for the entire portfolio, we estimate our regulatory capital ratios would have improved by about 20 basis points due to the reclassification of a portion of the previous impairment losses to accumulated other comprehensive income.

We continue to monitor each of these portfolios very closely, with the assistance of an outside valuation firm. We did note accelerated prepayments in two of these portfolios in March and an improvement in the implied liquidity premiums for their valuation.

During the quarter we made significant progress in improving our capital position. We converted $114.1 million of our Series A preferred into common and we were able to shrink our balance sheet. These actions resulted in a 61 basis point improvement to our tangible common equity ratio to 4.65%.

Another indication of our improved capital position is our 80 basis point improvement in our tangible common equity to risk-weighted asset ratios to 5.19%. Our Tier 1 capital ratio improved by 31 basis points to 11.03%. Keep in mind the preferred conversion does not increase our Tier 1 capital.

We continue to be pleased with our Tier 1 and total capital ratios, however, we're aware of the recent focus on tangible common equity. As part of its efforts to focus on increasing tangible common equity, the Board of Directors has authorized management to pursue a discretionary equity issuance program that will allow Huntington to take advantage of market opportunities to issue new shares of common stock. Sales of the shares, if any, will be made by means of ordinary broker transactions on the NASDAQ Global Select market or otherwise at prevailing market prices. The authorization limits the maximum number of shares potentially issuable to 10% of the total shares outstanding, with an aggregate price of up to $100 million. There is no minimum issuance.

With the recent focus on tangible common equity, we completed specific actions in the first quarter, including improving the efficiency of our balance sheet and the conversion of certain shares of Series A preferred stock to enhance our capital position. In addition to the discretionary equity issuance program we have announced, we may consider similar actions in the second quarter.

Now with this, let me turn the presentation back over to Tim Barber to review credit trends.

Tim?

Tim Barber

Thanks, Don.

On an overall basis, our chargeoffs were lower in the first quarter than the fourth quarter of 2008 due to the lower Franklin Credit impact. However, the total loan portfolio continues to be negatively impacted by the sustained economic weakness in our Midwest market. The overall economic slowdown is impacting our commercial portfolio as reflected in the increase in net chargeoffs and non-accrual loans. The impact of the increasing unemployment rate in particular can be seen in our higher residential mortgage delinquencies.

On a non-Franklin basis, our commercial losses were higher and our consumer losses were lower compared with the prior quarter. Non-Franklin related C&I loan net chargeoffs were $82.3 million or an annualized 2.55%. The losses were concentrated in smaller loans as a result of the more active portfolio management process utilized throughout the quarter. We are reviewing criticized loans on a monthly basis with a focus on taking action as appropriate. From a geographic standpoint, the C&I net chargeoffs were concentrated in the Greater Cleveland and Akron/Canton regions.

The commercial real estate net chargeoffs were $82.8 million or 3.27%. The single family homebuilder segment continued to represent a significant portion of the losses. In the commercial real estate retail segment there was a $15 million loss associated with one project located in the Cleveland market. Combined, these two higher risk segments of the portfolio accounted for over 60% of the losses in the quarter. Aside from the one significant project, the losses were associated with smaller projects, consistent with our very granular portfolio profile.

Again, we were especially pleased with the result across our consumer portfolio during the quarter, particularly given the economic environment in our market.

Slide 23 represents the loss ratios associated with the portfolio. The commercial net chargeoff ratio increased as discussed while the combined consumer results were flat with the fourth quarter.

As shown on Slide 24, non-accrual loans and leases were $1.6 billion on March 31, representing 3.93% of total loans and leases. There was a $284 million decline associated with the Franklin restructure, so on a non-Franklin basis there was an increase of $335 million in the quarter. The $116 million non-Franklin-related increase in C&I non-accruals reflected the impact of the economic conditions in our market and were not concentrated in any specific region or industry. In general, the C&I loans supporting the housing or construction segment and loans associated with the auto industry are experiencing the most stress. Importantly, less than 10% of the C&I portfolio is associated with these segments.

The $184.2 million or 41% increase in the commercial real estate non-accruals reflected the continued decline in the housing market and stress on retail sales. The single family homebuilder and retail segments accounted for two-thirds of the increase. These continue to be the two highest risk segments of our commercial real estate portfolio.

The non-Franklin-related increases in residential mortgage and home equity non-accruals of $28 million and $7 million, respectively, reflected expected results given the market conditions.

On the other real estate owned front, we had a modest increase on a non-Franklin basis. The Franklin-related OREO is in the process of disposition as we have detailed the significant reduction over the last four months, consistent with our goals.

Slide 25 provides a summary of some key asset quality trends. Given our successful restructuring of the Franklin relationship, I will focus on the non-Franklin-related trends.

The non-accruing loan ratio increased to 3.04% as a result of the changes detailed on the previous slide, with a combined NPA ratio of 3.39%. Chargeoffs also increased in the quarter to 2.12%. The increase in the non-accruing loan and chargeoff ratios are connected as the number of loans that moved into non-accrual status had writedowns associated with the FAS 114 impairment analysis. This is tangible evidence of the enhanced portfolio management practices discussed by Steve and noted in prior slides.

Another observable result was the reduction in our commercial accruing 90-plus day delinquencies to zero in the quarter compared to $70 million in the prior quarter. The loans previously in this segment were either resolved or moved to non-accrual. The impact of this change, combined with the overall consumer performance, is seen in the lower 90-plus day accruing delinquency ratio of 35 basis points, the lowest it has been since the second quarter of last year.

Our reported allowance for credit loss ratio of 2.24% is down from the reported fourth quarter, but the impact of the Franklin restructure is clearly seen. On a non-Franklin basis, the allowance for credit losses increased from 2.01% to 2.27%. There was no Franklin-related reserve at the end of the quarter as the loans were acquired at fair value. While the resulting coverage ratios have declined, they represent an appropriate level of reserves for the remaining risk in the portfolio.

Turning to our auto finance portfolio, we were pleased with the performance in the first quarter. Slide 26 shows the auto loan portfolio delinquency and chargeoff trends. The decline in the level of delinquent accounts was consistent with our seasonal expectation, but given the environment it was not a foregone conclusion, as evidenced by the industry results in general. The lower dollar amount but higher ratio is a function of the $1 billion securitization we closed at the end of the quarter. We are focused on the dollar amount as that is a source for future losses. On the right side of the slide, our loss levels remain consistent in the first quarter, which we believe is another indication of the heath of the portfolio.

Slide 27 shows the early stage performance results for our indirect auto loans, with the declining trend evident in late 2008 and a more consistent trend beginning to develop. This is another basis for our view that our auto loan loss levels will peak in 2009.

Home equity loans and line also performed well in the quarter. As you can see from Slide 28, this portfolio had lower delinquencies and chargeoffs than the prior quarter. We continue with our active loss mitigation efforts and are very comfortable with the direction of the portfolio. Our portfolio management decisions and risk mitigation processes have allowed this portfolio to continue to perform consistently in the face of the declining economic environment.

Turning to Slide 29, our residential mortgage portfolio shows a generally increasing delinquency trend over the past five quarters, consistent with the impact of the market environment and the net chargeoff trend on the right side of the slide. We have significantly changed the orientation of the loss mitigation effort on this portfolio in the last 60 days and anticipate the impact will be seen in the coming quarters.

Turning to Slide 30, as Steve mentioned, during the quarter we initiated a portfolio review to better dimension our credit risk across the portfolio and particularly in the higher risk segments of the commercial real estate segment. This activity resulted in a reclassification of certain commercial real estate loans to C&I loans. The reclassification was primarily associated with loans to businesses secured by real estate and buildings that house their operations. These owner-occupied loans secured by real estate were underwritten based on the cash flow of the business and are more appropriately classified as C&I loans. This accounts for the decline in the overall period in commercial real estate outstanding from $10.1 billion at the end of the fourth quarter to $9.3 billion at the end of March.

The reclassification process also affected the single family homebuilder segment, as loans secured by one to four-family rental properties were removed from the single family homebuilder outstandings. This change more accurately reflects commercial real estate loans directly exposed to the deteriorating housing market. Our single family homebuilder outstandings now total $1.2 billion, down from $1.6 billion last quarter.

On the right side of the slide we have dimensioned the overall commercial real estate portfolio by property location. This enhanced disclosure indicates a concentration in our core footprint. Loans associated with projects in Florida total $324 million or 3%, while the 35 other out-of-market locations totaled $1.1 billion or 12%. None of the other states comprises more than 2% of the total. This combined out-of-footprint exposure is the result of a practice of following some of our Tier 1 borrowers to other geographies. Loans out of footprint are no longer being made.

Slide 31 shows an overall assessment of the commercial real estate portfolio and provides some detail on the two highest risk segments. A significant amount of time in the last quarter was spent on these two portfolios, and while both will continue to be impacted by the economic environment, we do not see either of them blowing out. The original underwriting and resource nature of the loans continues to provide a level of support for these projects.

Slide 32 provides some asset quality metrics for the two higher risk segments compared to the remaining segments and the overall commercial real estate portfolio. You can see the significant level of classified and non-accruing loans in the single family homebuilder portfolio and the recent increase in the retail segment. It was particularly important for us to review the retail portfolio as this is an evolving risk for the entire industry as opposed to the single family homebuilder segment, which has been top of mind for at least two years now. We continue to be cautiously optimistic regarding the rest of the commercial real estate portfolio performance.

Slide 33 provides an overview of the C&I portfolio, including some key asset quality trends. As discussed in prior periods, we have identified some higher risk segments within the portfolio, primarily associated with exposure to borrowers relating to the housing and auto industries.

Slide 34 provides a breakout of the C&I portfolio by these three higher risk segments. Of note is the fact that less than 10% of the portfolio is comprised by borrowers in these segments.

Slide 35 expands the auto industry related exposure to include our floorplan and other loans to dealers. We continue to be very comfortable with our floorplan exposure based on our client selection, underwriting and collateral monitoring processes. The bulk of our portfolio is associated with strong dealer groups that we believe will survive any consolidation in the coming months. Our historic performance in these segments speaks for itself.

Turning to Franklin Credit, Slide 36 updates the monthly collections from the portfolio. You can see the material impact our refinancing efforts had in March, resulting in the $22.4 million of collections. The closing on the refinance activity carried over into April, so we are comfortable with the expected results in April as well. Many of the work rules and strategies that we are now able to employ as a result of the restructure are expected to begin to show results in the second quarter. As evidenced by the collection results, the portfolio performed as expected regarding delinquencies.

Slide 37 is designed to provide a simple reconciliation of the balance sheet impact of the Franklin transaction between the last two quarters. The C&I portfolio declined by $650 million, while the consumer portfolio increased by $494 million, primarily in the residential mortgage portfolio, but with some attributed to home equity. We also added $80 million of residential OREO properties and that result was a $77 million reduction in assets and a $204.5 million reduction in non-performing assets. On a net basis, our Franklin exposure declined by $43 million as a result of the restructure and, importantly, payments from the collection activity.

This concludes the credit-related comments. Let me turn the presentation back to Steve for wrap up.

Stephen D. Steinour

Thank you, Tim. Let me share with you my updated expectations about 2009 performance. I'm on Slide 38.

First, we do not believe there'll be any significant economic turnaround this year and as a result we anticipate the net chargeoff levels as well as provision expense will remain elevated.

Second, our net interest margin may experience modest pressure from the first quarter's 2.97% level, although we're taking significant actions to respond to that.

Third, we will remain intensely focused on continuing to grow our core deposits. Deposit pricing is expected to remain competitive, but we expect to achieve this growth through improved sales and service execution and, quite frankly, a much stronger focus going forward on deposits.

Loan originations are expected to remain strong given the low absolute level of interest rates.

Fee income performance is likely to mirror that of the first quarter's strong performance in mortgage banking, brokerage and insurance, and with challenges in deposit service charges and trust income related to market valuations and conditions.

Expenses will remain well controlled and, as noted earlier, we expect to exceed our $100 million expense save target for this year.

Lastly, given the recent focus on tangible common equity, at yesterday's Board meeting the Board approved a discretionary equity issuance program and under this program we may issue up to $100 million of common equity going forward.

Slide 39 is my report card to you for the first 90 days. I won't go into that. It's been an energizing 90 days, a terrific time here in the company. We've got a lot that's been accomplished and certainly a lot more under way.

Slide 40, some important messages that we hope you and other investors will understand and take away. First, we think we've fully addressed Franklin. I don't plan on talking about it in the future. We believe we're now well positioned for opportunities.

Second, while the economy is weak and we're not counting on a recovery in the foreseeable future, I'm pleased to report that all of the credit work, the intensive reviews that have been done and many actions that we've taken - and I've been able to participate in a good number of them  leave me convinced that while credit costs in terms of net chargeoffs and provision expense will remain elevated, I don't see any blowouts on the horizon. And I believe we have the resources to manage through the problems that we're facing.

Third, capital is king and we'll continue to look for ways and opportunities to strengthen our capital ratios internally and we'll be relentless on our focus on making certain our balance sheet is managed very efficiently.

You may also be pleased to know that in my meetings with associates and customers in each region, I've come away very impressed by a depth of loyalty to Huntington. This is a huge, huge advantage for us to build upon as we go forward.

And lastly, though the industry's going through a period of heightened stress and uncertainty, the core business is good and getting stronger. Remember, we posted a 13% increase in our pre-tax pre-provision income from the fourth quarter.

In the foreseeable future, credit costs will normalize. We will return to normalized performance.

Slide 41 is the last of our slides. It represents the focus for the next 90 days. We've got a lot of opportunity, I think, to optimize the balance sheet and we'll be working on net interest margin and net interest income generation in that regard.

Second, we'll continue our efforts at cross-sell performance with benefits showing up in fee income growth and we'll look to drive those various fee income businesses.

Third, we need to make certain that the reorganization changes we've recently announced with our business segment are fully and effectively implemented early in the quarter.

Fourth, we will launch this quarter a strategic planning process for each business segment. This will be a new undertaking for the company. It will focus us in the future in terms of areas of growth, operating levers, if you will, for growth and investment.

And fifth, while this will always stay on the list, we have other actions to aggressively manage expenses and we'll continue to do that throughout the year. And as I noted earlier, we expect to exceed our $100 million expense save target for the year.

And lastly, we will actively position Huntington with some external campaigns that elevate awareness, strengths and continuity of the Huntington brand.

So we're going to open up for questions now. Thank you for your interest in Huntington.

Operator, would you open up for Q&A please?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Ken Zerbe - Morgan Stanley.

Ken Zerbe - Morgan Stanley

I guess my first question is regarding the $100 million discretionary equity offering. Do you guys have any internal stock price minimums where you would not want to issue shares because either the dilution or the capital impact would just not be worth it?

Donald R. Kimble

I think one thing we want to point is that in the first quarter we did improve our TCE and we did it opportunistically, and so if you take a look at the conversion of the preferred, the incremental TCE that we picked up per share was $4.60 a share and that compared to an average stock price of $1.85 a share. So we think that we've shown an interest in making sure that we don't do things that are going to be dilutive to our common shareholders anymore than what we absolutely have to.

And so that's why we like the structure that we have in place here or will have in place here shortly as far as the discretionary issuance program. It gives us the opportunity to be much more opportunistic and make sure that we're not issuing at inappropriate low levels as far as the stock price.

The other governor there is that the issuance is limited to no more than 10% of the common shares outstanding and so that also helps provide some additional control as far as the stock price achieved from that.

Stephen D. Steinour

So Ken, just to close out, in my mind it's another arrow in the quiver. We may use it if situations look attractive, but we're not feeling compelled to and we felt it was important to get a disclosure out promptly.

Ken Zerbe - Morgan Stanley

The second question is: What do you think's unique about your balance sheet that's leading to further NIM compression from here because a lot of other banks, even those with significant credit problems, are still guiding for NIM expansion in the next couple of quarters.

Stephen D. Steinour

I think we're just being cautious with you, Ken, quite frankly. We put a lot of on balance sheet liquidity on in the first quarter and that will give us some opportunities as we go into the second quarter and throughout the second half of the year; actions we're taking on the loan portfolio will start to come through. So we're trying to be conservative with our outlook for the year in general and so that's why we made that comment.

Ken Zerbe - Morgan Stanley

Okay, so if you do decide to reduce your liquidity somewhat, we could see some NIM expansion?

Stephen D. Steinour

That's right or simply if we just shifted to an investment portfolio versus an overnight fed fund.

Ken Zerbe - Morgan Stanley

The last question I had was when you chargeoff loans to go into non-performing, what's the magnitude of the writedown that you're seeing on those? I'm mostly curious about the commercial portfolio.

Stephen D. Steinour

There's a wide variance, Ken. It would be hard to, without misleading you, give you a generalization here. We've got anywhere from looking at unsecured or essentially unsecured where collateral's been converted by a defalcation with our borrower to fully secured that's cents on the dollar.

Operator

Your next question comes from Scott Siefers - Sandler O'Neill & Partners, LP.

Scott Siefers - Sandler O'Neill & Partners, LP

I guess, Steve, this question is probably best for you, just to follow up on the capital. Obviously you've been sort of receptive to the amount of significance that the market puts on TCE, but just given what you did last quarter - what you might do this quarter with the discretionary authorization - as you've gone through the last 90 days or so, do you have a sense what an appropriate TCE ratio is at Huntington, How aggressive you would be at getting there quickly versus trying to allow it to build over a period of several quarters?

Stephen D. Steinour

I don't, Scott. To try to answer you, I don't feel any pressure to get there quickly versus several quarters, to use your analogy. We found some opportunities last quarter. Maybe we'll find some this quarter, I don't know.

I feel very good in talking to you and others today about the work that has been done and the ongoing work in the various portfolios. Coming in with no in-depth review left me in a much disadvantaged position when we had the year end earnings call, so with 90 days into it I'm feeling pretty good. We still have a tough cycle to deal with but, again, I don't see any - to use our term - blowouts in the book, and for that reason I don't feel compelled to do anything.

I like our Tier 1 being over 11 and I think we're on track in terms of core performance and if we just stay focused and executing good things are going to happen. We'll hit the bottom here I hope soon and then start to - if we're not at it now - and then start what I think will be a sustained and nice recovery.

Scott Siefers - Sandler O'Neill & Partners, LP

If I could switch gears a bit, Tim, maybe this question is best for you, but you obviously had a lot of moving parts in the credit metrics this quarter. On the reserve, if we were to X out the Franklin-related reduction on sort of apples-to-apples basis, you did build the reserve with just the dollar amount of the provision versus the non-Franklin chargeoffs of only $213 million. Do you have a sense for potential magnitude of reserve build in coming quarters as we look ahead?

Tim Barber

Well, we did build the reserve net of chargeoffs by just under $80 million this quarter, this past quarter. I think we'll probably be in a slight build mode going forward, but there's still a lot up in the air here in our geography. We don't have a lot in Eastern Michigan or Northwest Ohio, but we do have some and so Chrysler and GM and important to us.

If what the Feds read on the economy in the second half is accurate - which, by the way, we're not positioning ourselves for, but if it is - then that should be very helpful to us late this year.

Operator

Your next question comes from Terry McEvoy - Oppenheimer & Co..

Terry McEvoy - Oppenheimer & Co.

As I look at just second quarter pre-tax pre-provision earnings and take out potentially the MSR hedging gain, so take into account some NIM pressure - I'm not quite sure of the incentive accrual reversals, which helped expenses in the first quarter, if that repeats itself - I'm essentially looking at kind of down sequential pre-tax pre-provision earnings. Would you agree with that conclusion and maybe what are some of the offsets to help that figure in the second quarter?

Donald R. Kimble

As far as the MSR, we had an MSR hedging loss last quarter of about $18 million through the fee income line item and that improved about a $3 million net loss for the fee income line, so net quarter-over-quarter we did have an improvement there. Some of that went through fee income and some of it went through margins. So I don't know that I would characterize that as being a gain from MSR; there was an improvement there. And I would say that the core level as far as expected impact for MSR hedging is probably more consistent with what we're experiencing here in the first quarter than what it has in previous quarters.

As far as the expenses, you mentioned the incentive reversals from the previous year. Keep in mind, too, that we didn't single out the expense increases associated with the severance for the work force reduction that we had. We had a reduction of over 500 employees during the first quarter and there was a cost there. And so, again, like the MSR, I'd say if we look at the expense levels that we're projecting for salary and benefits I'd say it's much more in line with the base case for where we are in the first quarter as opposed to adjusted for any one-time type of issues.

So I think as we look at the core for the first quarter, if you back out the goodwill write-off and back out the tax benefit for the Franklin restructuring, I'd say the core earnings ex provision are pretty much in line with where we think the base case is. I wouldn't say that there's unusual items in there that gave us any artificial lift or enhancement compared to what we'd expect for future quarters.

Terry McEvoy - Oppenheimer & Co.

And then the second question, just the reclassification of some CRE loans into C&I, were any of those commercial real estate loans set to refinance, they could not qualify for a commercial real estate credit and as such were moved to C&I, or was 100% of that simply a reclassification like you outlined?

Donald R. Kimble

100% reclassification, Terry.

Operator

Your next question comes from Anthony Davis - Stifel Nicolaus & Company, Inc..

Anthony Davis - Stifel Nicolaus & Company, Inc.

I guess this should be to Tim. Of the $1.6 billion that you've got in NPLs right now, Tim, I want you to tell us what percentage of those loans are FAS 114s and in a range here perhaps the cumulative mark that you have taken on those loans that are non-accrual from the original book.

Tim Barber

Tony, I think the answer to that question is essentially the answer that we gave a little earlier. It varies dramatically across the type of loan in the commercial and commercial real estate world. I don't know right off the type of my head exactly what the number is specifically FAS 114 within the non-accrual. You can see what the overall commercial and commercial real estate numbers are.

Mike Cross is here and he might be able to shed a little light on that.

Michael Cross

Of the $1.6 billion, all of that went through the 114 impairment analysis that we conduct every month. And Tim and Steve previously commented that the amount of the mark depends upon the deal in general, but any asset that we had in that portfolio that was secured by real estate, the marked-to-market was done based upon a current evaluation or appraisal that we have, so that's the discipline that we have in that regard.

Anthony Davis - Stifel Nicolaus & Company, Inc.

While I've got you, the other question I have was the status, I guess, Mike, of the negotiations that's Franklin's having to procure additional servicing contracts. Maybe you could give us some color on the degree or interest, the dialogue you're having now as opposed to prior to the restructuring, and also what it might mean [inaudible] and whether that platform is at some point sold.

Michael Cross

Tony, I'll answer you with a non-answer. I would refer you to Franklin Credit to talk about specifics in regards to the opportunities that they have before them. As you know and we have announced beforehand, this structure that we put in place at the end of the first quarter gives them the freedom to have tremendous opportunity and their entry into the cycle right now, I think, the timing is almost perfect.

We also, as you know pursuant to our previous disclosure, we have an exciting opportunity in terms of the ability to have them service our portfolio. We're pleased with their performance. We now have flexibility that we didn't have before with the standard creditor-debtor relationship so they have, as Tim previously stated, essentially exceeded our expectations or met our expectations in terms of what they've been able to do with our portfolio. So I think they'll be able to replicate that with other clients if they're lucky enough to get servicing contracts with those folks.

Operator

Your next question comes from Mark Lynch - Wellington Management.

Mark Lynch - Wellington Management

I see your average loan yield is down to 4.9%. Your average yield on commercial real estate's down to 3.76% and commercial industrial 4.6%. All those seem pretty low and I'm wondering are there a lot of floors in your portfolio and, as you work through and renegotiate, can you put floors in and how fast can you do that?

Michael Cross

We're putting floors in in virtually every deal that's renegotiated, but as a rule we do not have floors in on the commercial real estate book. It's one of the challenges.

Mark Lynch - Wellington Management

And the C&I loans would take, what, two years on average to get it in?

Michael Cross

No, I think we're going to see the vast majority of it come through between this first quarter and the next four quarters, so I'd say an effective duration of maybe five quarters.

Mark Lynch - Wellington Management

And on the CRE, if you put in the floors, can they actually pay them or is it kind of a moot point?

Michael Cross

Well, it depends on the borrower, obviously. The vast majority are performing so we would expect those floors to have some teeth and they are being reprised on the CRE book as well.

Operator

Your next question comes from Greg Ketron - Citigroup.

Greg Ketron - Citigroup

I had a question on the sustainability or at least your view on the sustainability of the mortgage banking income now we've seen gain on sell margins widen appreciably and whether you thought that could continue or if that was your experience there as well as maybe some views as to whether you feel like you're picking up market share within your marketplace on the mortgage side.

Donald R. Kimble

We think it's sustainable certainly for the near term. We do believe we have a share pickup going on of a modest nature and it's actually an area where we're looking at whether we want to make an immediate investment and try and continue to accelerate the share pickup or not.

Greg Ketron - Citigroup

Did you see gain on sale margins improve significantly as well?

Stephen D. Steinour

We did see them improve in the first quarter just as a result of the dramatic changes that occurred in the rates during that time period and the significant inflow of the refinance activity.

Greg Ketron - Citigroup

Then one last question. I know this may be a difficult subject to comment on, but any preliminary views on the Treasury programs that are out there, including the CAP program.

Stephen D. Steinour

We are following, I think, like most of you what's being offered and as it develops, but we don't have views on any of it and we don't believe we have any need to pursue any of the programs. If we happen to find one that's opportunistic - as you know, we issued under TALF - we might take advantage of it.

But in terms of the CAP program or TARP II or anything else, we don't believe we had any need.

Operator

This concludes the question-and-answer portion of today's call. I'll now turn the call back to Mr. Gould for any closing remarks.

Jay Gould

Thank you, [Abigail], and thank you, everybody, who's shown interest in participating today. If you have follow up questions, please give myself or Jim a call. Thank you so much.

Operator

This concludes your conference call for today. You may now disconnect.

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